Morning Cup of Jo: A Rough Start so Far

Keep in mind we've also got CPI data and a speech from Chairman Bernanke next week which could provide some reason for pause.

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"Things don't turn up in this world until somebody turns them up." James A. Garfield

Key Points:

As Wall Street continues to wrestle with the economic picture unfolding (including Friday's BLS data) some institutions are turning toward more defensive names.

The Retail Drug Group is building an inverted Head & Shoulder base. It has yet to break the neckline but has the distinctive volume profile associated with this pattern.

The longer-term graph (just over five years) highlights a massive five year Cup and Handle base.

How the group acts at these key levels could shed some light on the broader question of whether we will see a continuation of the money flows trend into defensive names (staples, utilities, healthcare) or a rotation into other sectors of the market.

Market Commentary:

Since last week's Jo the markets have certainly been on quite a roller coaster ride. The good news is the SPX and RUS have held their respective 200-DMA's and the NDQ hasn't broken last month's low on a closing basis.

Even so, Wall Street is still questioning last Friday's Bureau of Labor Statistics report. This report emphasized the largest increase in wages in over 5-years and led to a corresponding 134 point drop in the Dow Jones Industrials leaving numerous managers continuing to search for alternative, more defensive investments. On a technical basis there are obvious areas of interest, more so than others. One group, Retail Drug Stores, was highlighted on Monday with the large stake taken in Rite Aid (RAD) by Tudor Investment Group. Founder and billionaire Paul Tudor Jones II disclosed in a regulatory filing on Friday that they increased their percent ownership from 4.2% to 5.3% and became the third largest shareholder with 28.5 million shares.

Was this move made because of a possible buyout by one of the other major chains, or was it simply a market defensive strategy? This question will continue to remain unanswered, for now. Investors like so-called defensive stocks, such as drugstores, because they are less apt to suffer in an economic slowdown. Additionally, on a more fundamental note, same store sales for the group seem to be exceeding strong. There are really only three other major players in this space Walgreen (WAG), CVS (CVS) and Longs Drug Stores (LDG).

To help answer the fundamental question of why money is flowing into this group we can take a look at some of the most recent news…

On July 5th WAG reported its YTD sales of $23.85 bln, up 12.2% from last year, and a 14.2% increase in June sales from the previous year.

On July 6th RAD reported a 3.6% increase in same store sales with a 4.6% jump in total sales.

On July 7th LDG reported a 9.5% sales growth in June, up 3.7%.

On Monday July 10th CVS reported an 8.4% rise in June on same store sales with a 23% increase in total sales to $4.3 bln.

Given the fundamental news within the sector over the last week and looming economic backdrop of possible tougher times ahead, it's only prudent to look at the technical condition of the group. First let's look at the shorter-term picture:

As you can see, the group, which is extremely small and only contains seven companies, is building a Head & Shoulder base. It has yet to break the neckline but has the distinctive volume profile associated with this pattern.

When looking at a longer-term graph (just over five years) we also see a familiar pattern:

The industry group has built a massive Cup & Handle base over this period. On the longer-term graph you notice how the handle incorporates the inverse Head & Shoulders pattern from the shorter-term chart.

Nonetheless, I cannot stress enough; this is not a recommendation but purely an example of some money flow directional changes the market has been going through over the last few quarters. After looking at what happened to the markets over the last week with the advent of 3M's (MMM) lowering guidance, EMC's (EMC) warning, Lucent Tech.'s (LU) profit warning and Alcoa's (AA) miss, there are many professional money manages looking for places to stash their cash.

As the charts clearly illustrate, the retail drug store space is currently hovering at important inflection points. How the group acts at these levels could shed some light on the broader question of whether we see a continuation of the money flow trend into defensive names (staples, utilities, healthcare) or a rotation back into the more traditional growth sectors of the market – such as technology.

Yesterday did however bring a glimpse of light for the Bulls. After starting out down, following the bombings in India, the "Four Sisters" found their makeup bag when analysts walked out of the afternoon meeting with KLA Tencor (KLAC) beholden with positive news for the semiconductor industry and sparked a rally for the badly beaten-down technology sector.

The markets are certainly off to a rough start so far with respect to second quarter earnings, albeit still in the early innings. Keep in mind we've also got CPI data and a speech from Chairman Bernanke next week which could provide some reason for pause.

As for our "Eye on the Ball" table above we have changed some numbers slightly since last week. All the same, it is important to point out all the Sisters bounced off the ST support levels yesterday morning and managed to squeak out a gain for the day.

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